A subcontractor has no direct contractual relationship with a project owner; that relationship is between the general contractor and the owner. Accordingly, the subcontractor cannot sue the owner directly if it sustains money damages caused by the owner. Consequently, in response to this lack of contractual privity, the subcontractor and the general contractor may enter into a liquidating agreement, or pass-through agreement, where the sub assigns its claim to the general contractor. The general contractor, in turn, would then prosecute the subcontractor’s pass-through claim against the owner, and then give the subcontractor any recovery.
Generally, a liquidating agreement is designed to limit or liquidate the general contractor’s liability to the subcontractor to the amount the general contractor recovers from the subcontractor.
In the recent case of Rod and D’Aprile, Inc. v. Arnell Construction Corp., the appellate court addressed the general contractor’s duty of good faith and fair dealing under a liquidating agreement.
In June of 2001, the New York City Department of Sanitation entered into a contract with Arnell Construction Corp., as general contractor, to construct two new sanitation garages in Brooklyn. Arnell’s contract with the City required that any claims against the City be brought within six months of the City’s issuance of the certificate of substantial completion for the project. In August of 2001, Arnell subcontracted with Rad & D’Aprile, Inc., for Rad & D’Aprile to perform certain masonry work on the project.
In August of 2010, pursuant to a liquidating agreement it had entered into with the subcontractor, Arnell filed a notice of claim with the City seeking damages on behalf of Rad & D’Aprile for additional costs that the subcontractor incurred due to various delays caused by the City. In September of 2010, Arnell commenced an action against the City on those claims. The City moved to dismiss that lawsuit on the ground that it was untimely under the six-month limitations period provided for in Arnell’s contract. The court granted the motion, finding that the City had notified Arnell in December 2007 that the project was substantially complete, and that any lawsuit had to be commenced no later than June of 2008.
After that lawsuit was dismissed, Rad & D’Aprile sued Arnell directly for the same damages. In its second cause of action, Rad & D’Aprile alleged that Arnell had a duty to make a good-faith, diligent effort to prosecute the claim it asserted against the City on the subcontractor’s behalf, and that Arnell breached that duty by failing to commence the lawsuit against the City within the applicable six-month limitations period.
Arnell moved to dismiss Rad & D’Aprile’s complaint, arguing that it did not state a claim upon which relief could be granted. The court denied the general contractor’s motion to dismiss the subcontractor’s second cause of action for the breach of the liquidating agreement, finding that Rad & D’Aprile set forth facts sufficient to establish that Arnell had a duty of good faith and fair dealing independent of the subcontract, and that the general contractor breached that duty by failing to commence the underlying action before the six-month limitations period expired.
Arnell appealed, and the appellate court affirmed the lower court’s denial of the dismissal of the breach of the liquidating agreement claim. The appellate court relied on well established case law that the liquidating agreement, like every other contract, contained a covenant of good faith and fair dealing. Here, the appellate court held that duty of good faith and fair dealing “require[d] the general contractor to ‘take all reasonable steps so that the [subcontractor’s] right to an eventual recovery, if any, from the [owner] w[ould] be protected”. The facts set forth in the complaint sufficiently alleged that Arnell breached that duty by failing to timely prosecute the subcontractor’s claims.
Liquidating agreements are an effective way to address the problem of a subcontractor’s lack of a contractual relationship with a general contractor by having that general contractor essentially admit the validity of the subcontractor’s claims, confess liability on those claims, and then prosecute those claims on behalf of the subcontractor with the promise that the recovery would be passed along to the aggrieved subcontractor. The benefit to a subcontractor is that claims which would otherwise be barred because of the lack of privity of contract with the owner can be adjudicated. The benefit to the general contractor is that its liability is limited to the amount it ultimately recovers on the liquidated claims. However, as we can see from Rad & D’Aprile, in order to enjoy the protection of that limitation of liability, the general contractor must be diligent in prosecuting the subcontractor’s liquidated claims. General contractors and prime contractors would be well advised to take their responsibilities under a liquidating agreement seriously or else be prepared to be held responsible for the subcontractor’s claims.